67 terms

CIA Part 3 - SU 8

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Vertical Integration
combines within a single firm production, distribution, selling, or other separate economic processes needed to deliver a product or service to a customer.

Uses internal or administrative transactions for these purposes in the expectation they will increase efficiency or decrease costs and risks.
Whether integration should occur
Depends on:
1) the firm's volume of transactions with the external parties (throughput) and
2) The magnitude of the capability required to achieve necessary economies of scale.
Strategic Benefits of Vertical Integration
1) Upstream (backward) integration
2) Downstream (forward) integration
Upstream (backward) integration
acquisition of a capability that otherwise would be performed by external parties that are suppliers of the firm.
ex: a car manufacturer acquires a company that supplies tires for automobiles
Downstream (forward) integration
acquisition of a capability performed by customers.
ex: a car manufacturer acquires car dealerships that sell and lease the company's cars.
Economies of vertical integration
occur when throughput is great enough to achieve economies of scale.

1) Economies of combined operations
2) Economies of control and coordination
3) Economies of information
4) Economies result from avoiding some market transactions
5) Stable relationships between internal sellers and buyers create economies.
Strategic Costs of Vertical Integration
1) Integration is a special case of entry into a new business
2) Integration increases fixed costs and operating leverage, which is in itself a cause of increased business risk.
3) Integration reduces the flexibility to change business partners because it increases the costs of switching to different suppliers or customers.
4) Integration may increase exit barriers.
5) Integration requires investment capital.
6) Integration may foreclose access to supplier or customer technology.
7) Integration requires maintaining a balance among the operations of the firm's subunits.
8) Integration may reduce incentives.
9) A significant cost and risk of integration is that subunits have differing managerial requirements.
Forward Integration improves
a) the timeliness of demand information
b) production planning
c) inventory control
d) the costs of being under- or overstocked
Backward Integration
a) allows the firm to protect is proprietary knowledge from suppliers
b) controlling inputs may permit the firm to differentiate its product more effectively, or at least to argue persuasively that it does so.
Tapered (partial) integration
implies that the firm can fully support an efficient subunit but has additional needs to be met in the market. If the in-house subunit will not be efficient, that inefficiency must be weighed against the benefits.
- results in lower fixed costs that full integration
- risks include greater coordination cost and selling to, or buying from, competitors.
Advantages of tapering
a) avoidance of locked-in relationships
b) some access to external expertise
c) increased managerial incentives
d) offering a credible threat of full integration to suppliers or customers
e) obtaining knowledge of the adjacent business and an emergency supply source
Quasi-integration
something more than a long-term contract and less than full ownership. It may be achieved by a minority common stock interest, debt guarantees, cooperation in R&D, an exclusive dealing arrangement, etc.
- buyer and seller may, as a result, have a common interest leading to lower costs, smoothing of supply/demand fluctuations, or mitigating against bargaining power.
- may avoid commitment to an adjacent business with its investment and management requirements.
Common Illusions of Integration
a) strength in one pat of the chain necessarily carries over to the other parts.
b) doing something internally is less expensive.
c) integrating into a highly competitive business is often wise.
d) integration may save a strategically sick firm.
e) experience in one part of the chain always carries over to other parts.
Capacity Expansion
The key forecasts are long-term demand and behavior of competitors.
Overcapacity
Tends to be a long-term problem because firms are more likely to compete intensely rather than reverse their expansion.
Undercapacity
Tends to be a short-term issue. Profits ordinarily attract more investors.
Porter's model of the decision process for capacity expansion
1) the firm must identify the options in relation to their size, type, degree of vertical integration, and possible response by competitors
2) the second step is to forecast demand, input costs, and technology developments.
3) the next step is analysis of competitors to determine when each will expand.
4) using the information from the first 3 steps, the firm predicts total industry capacity and firms' market shares. these estimates, together with the expected demand, permit the firm to predict prices and cash flows.
5) the final step is testing for inconsistencies.
Excess preemption
leads to excess industry capacity because firms
a) overestimate their competitive strengths
b) misunderstand market signals, or
c) fail to accurately assess competitors intentions
Causes of Overexpansion (overbuilding)
a) occurs when existing firms overexpand production capabilities to take advantage of current undercapacity in an industry.
b) most frequent in firms that produce commodities
c) technological factors
d) when minimum efficient scale increases, large plants are becoming more efficient.
e) changes in production technology result in new construction while old plants remain in operation, particularly when exit barriers are high.
Structural factors that may lead to overbuilding
1) when exit barriers are high, the period of overcapacity is extended.
2) competitive pressures on suppliers of capital, equipment, materials, etc., may promote expansion by customer industries.
3) credibility of new products is promoted by capacity expansion that gives assurance to large buyers. such customers need to know that capacity will exist to meet their long-term needs and that a few suppliers will not have excessive bargaining power.
4) when competitors are integrated, the pressure to build despite uncertain demand intensifies.
5) capacity leadership is important in some industries as a means of increasing market share.
Competitive factors that may lead to overbuilding
1) many firms with the ability to add capacity want to improve market share.
2) the lack of a credible market leader makes for a less orderly expansion. a stronger leader can retaliate effectively against inappropriate expansion by others.
3) new entrants, possibly encouraged by low entry barriers and favorable economic conditions, may cause or intensify overcapacity.
4) first mover advantages may be significant.
Information flow factors that may lead to overbuilding
1) future expectations may be inflated because of industry buzz
2) firms assumptions or perceptions about competitors' strengths, weaknesses, and plans may be in accurate.
3) market signaling may be ineffective bc it is no longer regarded as credible.
4) changes in industry structure may lead directly to new investment or create uncertainties leading to faulty decisions.
5) the financial community encourages overbuilding when analysts criticize firms that have not expanded.
Managerial factors that may lead to overbuilding
1) mgmt that is production-oriented may be more likely to ovebuild than marketing or finance-oriented mgmt.
2) a manager's career risk is asymmetric when the consequences of overcapacity appear to be less serious than those of undercapacity.
Governmental factors that may lead to overbuilding
1) tax incentives may promote excess capacity
2) a nation may wish to create a local industry
3) governmental employment pressures may result in overbuilding to create jobs or avoid job loss.
Limits on capacity expansion
1) most firms have great uncertainty about future conditions
2) the firm faces financial limitations
3) the firm is diversified
4) senior managers have finance backgrounds
5) expansion is costly
6) the firm's behavior sends signals to competitors that building is unwise
Preemptive Strategies
requires investments in plant facilities and the ability to accept short-term unfavorable results. the strategy is risky because it anticipates demand and often sets prices in the expectation of future cost efficiencies.
Conditions that must be met for a preemptive strategy to succeed
1) the expansion must be large relative to the market, and competitors must believe that the move is preemptive.
2) economies of scale should be large in relation to demand, or the learning-curve effect will give an initial large investor a permanent cost advantage.
3) the preempting firm must have credibility to support its statements and moves, such as resources, technology, and a history of credibility.
4) the firm must provide credible signals before actions by competitors
5) the competitors of the firm should be willing not to act.
Ways to enter into new businesses
through:
1) Internal Development
2) Aquisition
3)
Entry through internal development
ordinarily involves creation of new business entity.
Forecasts
attempt to answer questions about the outcomes of events. The basis for business plans.
Forecasting Methods
a) Qualitative (judgement) methods
b) Quantitative methods
Qualitative Methods
Rely on experience and human intuition. (judgement)
Delphi Method
summarizes the opinions of experts regarding a given problem. These summaries are then fed back to the experts without revealing the identities of the other participants. The process is repeated until the opinions converge on an optimal solution.
Quantitative Methods
use mathimatical models and graphs.
Causal Relationship Forecasting
quantifies the link between some factor in the organization's environment (the independent variable, plotted on the horizontal axis) and an outcome at a moment in time (the dependent variable, plotted on the vertical axis)
Time series analysis
relies on past experience to project future outcomes. Includes trend projection, moving average, exponential smoothing, and learning curves.
Trend Analysis
fits a trend line to the data and extrapolates it.
Moving Average
appropriate when the demand for a product is relatively stable and not subject to seasonal variations. Each periods average includes the newest observation and discards the oldest one.
Exponential Smoothing
useful when large amounts of data cannot be retained. Greater weight is placed on the most recent data.
Learning Curves
reflects the increased rate at which people perform tasks as they gain experience. The time required to perform a given task becomes progressively shorter during the early stages of production.
Best known learning curve models
1) cumulative average-time learning model
2) incremental unit-time learning model
Cumulative average-time learning model
the assumption is that the cumulative average time per task decreases by a constant percentage each time the cumulative quantity of tasks doubles.
Incremental unit-time learning model
the assumption is that the incremental (additional) time to perform the last task decreases by a constant percentage each time the cumulative quantity of tasks doubles.
Simulation
experiments with logical and mathimatical models using a computer.
Steps in simulation
1) define the objectives
2) define the variables, their individual behavior, and their interrelationships in precise logical-mathimatical terms.
3) obtain some assurance that the model will adequately predict the desired results
4) design the experiment
5) perform and analyze the results using appropriate statistical methods
Monte Carlo Simulation
uses a random number generator to produce individual values for a random variable.
Sensitivity Analysis
examines how the model's outcomes change as the parameters change
Markov Process
quantifies the likelihood of a future event based on the current state of the process.
Game Theory
a mathimatical approach to decision making when confronted with an enemy of competitor.
Zero-sum Game
a two player game, if the payoff is given by the loser to the winner.
Positive-sum game
a two player game where it is possible for both plaers to profit
Cooperative game
the players are permitted to negotiate and form binding agreements prior to the selection of strategies.
Prisoner's dilemma
a special outcome of a partly competitive game in which each player has a strategy that dominates all other strategies. However, when each player chooses his or her dominant strategy, the outcome for both is less favorable than if one or both chooses some other strategy.
Maximax criterion
applied by risk-seeking, optimistic decision makers. They select the option with the highest potential payoff regardless of the state of nature.
Maximin criterion
applied by conservative (risk-averse) decision makers. They select the option with the lowest potential loss from the set of worst possible outcomes for each alternative. ("the best of the worst")
Insufficient reason (Laplace) criterion
may be used by a risk-neutral player when probabilities cannot be assigned.
Expected value criterion
may be used by a risk-neutral player, that is, one for whom the utility gain is the same as the disutility of an equal loss.
Expected Value of a decision
is found by multiplying the probability of each state of nature by its payoff and adding the products.
Simple Regression
used when exactly one independent variable is involved
y = a + bx
Regression analysis
the process of deriving the linear equation that describes the relationship between two variables.
y = a + bx
the simple regression equation - the algebraic formula for a straight line
y = the dependent variable
a = the y intercept
b = the slope of the regression line
x = the independent variable
Multiple Regression
used when there is more than one independent variable. Allows a firm to identify many factors and to weight each one according to its influence on the overall outcome.
y = a + b1x1 + b2x2 + etc
High-Low Method
used to generate a regression line by basing the equation on only the highest and lowest of a series of observations.
Correlation Analysis
the strength of the linear (straight-line) relationship between two variables, expressed mathematically in terms of the coefficient of correlation, r
- perfect direct relationship (r = 1)
- perfect inverse relationship (r = -1)
- strong direct relationship (r = 0.7)
- no linear relationship (r = 0)
Coefficient of determination
r^2, a measure of how good the fit between the independent and dependent variables is.
- mathimatically it is the proportion of the total in variation in the dependent variable that is accounted for by the independent variable.
- value ranges from 0 to 1. The closer it is to 1, the more useful the independent variable (x) is in explaining or predicting the variation in the dependent variable (y)
Standard Error
measures how well the linear equation represents the data. The vertical distance between the data points in a scatter diagram and the regression line.
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